Tag Archives: AXA

It’s been a while since I posted on the specialty insurance sector and I hope to post some more detailed thoughts and analysis when I get the time in the coming months. M&A activity has picked up recently with the XL/AXA and AIG/Validus deals being the latest examples of big insurers bulking up through M&A. Deloitte has an interesting report out on some of the factors behind the increased activity. The graph below shows the trend of the average price to book M&A multiples for P&C insurers.

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As regular readers will know, my preferred metric is price to tangible book value and the exhibit below shows that the multiples on recent deals are increasing and well above the standard multiple around 1.5X. That said, the prices are not as high as the silly prices of above 2X paid by Japanese insurers in 2015. Not yet anyway!

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Unless there are major synergies, either on the operating side or on the capital side (which seems to be AXA’s justification for the near 2X multiple on the XL deal), I just can’t see how a 2X multiple is justified in a mature sector. Assuming these firms can earn a 10% return on tangible assets over multiple cycles, a 2X multiple equates to 20X earnings!

Insurers and industry participants have reacted with the expected bemusement to the announcement on the 18th of July from the Financial Stability Board (FSB) on the list of “too big to fail” insurers, aka G-SIIs or Global Systemically Important Insurers. To be fair, the list of nine – three US, five European and one Chinese – does look inconsistent. No Japanese for example or the inclusion of Aviva but the exclusion of Zurich.

Industry groups such as the Geneva Association and Insurance Europe have asked for clarity on the criteria and more disclosure on the impact. The timetable released by the FSB includes announcing the reinsurers to be designated as G-SIIs by mid 2014 (now that will be interesting given the global focus of a reinsurer’s business model) and the finalization of the additional loss absorption measures for G-SIIs by the end of 2015 with an implementation date of the start of 2019.

The generous diversification credits that large insurers have calculated using economic capital models (likely to be used under Solvency II) can be seen in the graph below based upon data from a sample of published results from 2012 annual reports of a number of European insurance groups.

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The graph shows assumed diversification across risk modules of 30% to 40% but does not show the significant diversification assumed by insurers within risk modules, particularly for the larger firms with a wide spread of business classes. Munich Re, for example, highlights a further 30% and 50% discount in their non-life underwriting risk and market risk modules respectively. Aviva is perhaps startlingly open when it revealed, in its year end results presentation, a diversification discount within its business unit of 45% and a further diversification discount across business units and jurisdictions of 40%. Their gross undiversified capital of £31 billion reduced by 68% to £10 billion after been sprinkled with the diversification magic dust.

Given the competitive advantage that size and diversity brings under the risk based regulatory capital systems being introduced or planned for introduction across the globe, the large insurance groups just named as G-SIIs will likely step up their lobbying efforts to a new level in the next few years against any costly or detrimental measures by the FSB that could impact their hard won competitive advantage. Another avenue for the G-SII to negate any capital impact is to sharper their pencils further on the diversification effects calculated in their economic capital models!

Disclaimer

This blog represents my personal views and is not reflective of the views or opinions held by any company or employer I work for currently or have worked for in the past. The views expressed herein are based solely upon publicly available data. No views expressed herein should be taken as an endorsement to take any particular course of action in the markets. The basis of this blog is that different views should be expressed and readers make up their own minds on the what they believe and act accordingly.